S&P 500 Trading Strategies and Stock Betas

this paper shows that S&P 500 stock betas are overstated and the non-S&P 500 stock betas are understated because of liquidity price effects caused by the S&P 500 trading strategies. The daily and weekly betas of stocks added to the S&P 500 index during 1985-1989 increase, on average, by 0.211 and 0.130. The difference between monthly betas of otherwise similar S&P 500 and non-S&P 500 stocks also equals 0.125 during this period. Some of these increases can be explained by the reduced nonsynchroneity of S&P 500 stock prices, but the remaining increases are explained by the price pressure or excess volatility caused by the S&P500 trading strategies. I estimate that theprice pressures accountfor 8.5 percent of the total variance of daily returns of a value-weighted portfolio of NYSE/AMEX stocks. The negative own autocorrelations in S&P 500 index returns and the negative cross autocorrelations between S&P 500 stock returns provide further evidence consistent with the price pressure hypothesis.

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